Educational Articles

From the Survey: Berkshire Hathaway

Ian Gendler
| June 25, 2011

Berkshire Hathaway (BRKB) is one of the largest publicly traded companies in the United States, with more than 260,000 employees. It operates several large insurance businesses, as well as more than 80 subsidiaries that range from ice cream manufacturing to electric utilities. However, like most large corporations, Berkshire started out small.

Hathaway Meets Berkshire

In 1888, Horatio Hathaway, with funds obtained from a whaling business in the Pacific Ocean, started to mill cotton and formed the Hathaway Manufacturing Company. The business quickly became profitable. However, after World War I, the demand for cotton declined sharply. Soon after, the situation improved, and in the 1950s, it merged with Berkshire Fine Spinning Associates, a milling company that can trace its roots back to the early 1800s. For the time, the combined entity was massive, with 15 manufacturing plants, more than 12,000 workers, and annual revenues that exceeded $120 million. The combined company was run by Seabury Stanton, who was an expert miller and manager, but lacked extensive financial knowledge. Stanton proposed a number of strategies to expand the business, which turned out to be unsuccessful. By the end of the 1950s, the company fell on hard times, and was forced to close nearly half of its plants, and reduced its workforce materially. Its stock price fell accordingly.

Enter Warren Buffett

Warren Edward Buffett was born in Omaha, Nebraska in 1930. After graduating from the University of Nebraska, he studied business at Columbia Graduate Business School under Benjamin Graham. Soon after graduation, he went to work at Mr. Graham’s firm, and later started his own limited partnership in Omaha. In 1962, he believed that Berkshire Hathaway, although struggling, was undervalued; he began buying shares. A year later, Mr. Buffett and a few associates were Berkshire’s largest shareholders, and soon owned 49% of the company. They quickly took an active interest in the operation and pushed for a management change. Mr. Buffett installed Ken Chase to run the mill business, while he focused on improving the company’s financial position.

In 1967, Berkshire entered the insurance business with the purchase of two Nebraska companies, National Indemnity and National Fire and Marine Insurance. Mr. Buffett recognized that insurance operations have the ability to be an effective vehicle for raising capital. When a company sells insurance policies to individuals, businesses, municipalities, and other entities, it receives premiums upfront and pays claims, if necessary, down the road. Thus, this business allows the insurer to hold large sums of money, which is referred to as the float. The float can then be invested, and/or used to make acquisitions. The investment gains, for the most part, are cost free.

GEICO

The Government Employees Insurance Company was started in 1936 by Leo Goldwin. Its purpose was to provide inexpensive insurance to government employees. Benjamin Graham, Warren Buffett’s mentor, took an interest in the company and, at one time, was a 50% owner. Mr. Buffett bought shares, as well, and was very interested in GEICO, since the company’s float was substantial. However, GEICO struggled mightily during the 1970s, thanks to the writing of higher-risk policies. At this time, GEICO stock fell from $42, to $2 a share. Mr. Buffett’s interest appeared never to waiver and he continued to increase his position. Finally, in the beginning of 1996, Berkshire Hathaway purchased the remaining shares of GEICO, and it became a wholly-owned subsidiary.

At the time GEICO was welcomed into the Berkshire Hathaway family, it was the sixth largest automobile insurer in the United States. Now, it is third, and offers its products in 44 of the 51 American jurisdictions. GEICO’s market share has increased four-fold over the past 15 years (since Berkshire took full control), and now accounts for more than 8% of the total market. With the backing of Berkshire, it can, in most cases, offer lower insurance rates than its competition, and with an advertising budget that exceeded $900 million in 2010 alone (more than twice the amount spent by any other auto insurer), GEICO’s long-term prospects appear solid. Over the years, Berkshire developed and added a number of other large insurance and reinsurance businesses, all of which contribute meaningfully to the company’s bottom line. Also, these operations, as mentioned earlier, create substantial float. For comparison purposes, Berkshire’s float amounted to $16 million in 1967. At the end of 2010, Mr. Buffett had nearly $66 billion to invest.

Other Businesses

During the decades since Mr. Buffett and his partner Charles Munger took control of Berkshire Hathaway, it has completed dozens of non-insurance acquisitions. Today, it operates candy manufacturers, clothing retailers, building materials companies, an aircraft ownership entity, and many more. Most notably, at the beginning of 2010, the company completed the $34 billion purchase of railroad Burlington Northern Santa Fe. As a result, Berkshire now owns more than 32,000 miles of track in the U.S. It is the largest acquisition ever completed by the company.

Berkshire’s size and scope of operations is impressive. It used insurance float and profits from its other businesses to create and accumulate a vast equity portfolio. At this time, it owns large pieces of blue chips Coca-Cola (KO – Free Coca-Cola Stock Report), American Express (AXP –Free American Express Stock Report), Wal-Mart (WMT – Free Wal-Mart Stock Report), and Johnson & Johnson (JNJ – Free J&J Stock Report), among others. Currently, the portfolio’s value exceeds $53 billion. Stock dividends and corporate profits, along with the insurance float, are commonly used to make acquisitions, increase its equity portfolio, and expand the company’s current operations, a strategy that will likely continue in perpetuity.

The Stock

Investors that took a position in Berkshire Hathaway when Mr. Buffett and Mr. Munger took the reins have been richly rewarded. In fact, in the late 1960s, Berkshire A-shares traded for around $20. At the end of 2010, one share was worth about $120,000; an annual gain, on average, of 23%. In 1996, Berkshire introduced B-shares which, at the time, were worth 1/30 of an A-share. However, in order to help facilitate the purchase of Burlington Northern Santa Fe, Berkshire split the B shares 50-for-1, and they are now worth 1/1500 of an A-share. For most investors, purchasing a single share of stock for six-figures is not possible--the B-shares allow the majority of the investment community to own a piece of Berkshire Hathaway.

Berkshire Hathaway Today

Omaha, Nebraska-based Berkshire Hathaway is run by legendary investor Warren Buffett, and is one of the largest corporations in the United States, with a market capitalization of more than $185 billion. Its operations are divided into three segments: Insurance and Other; Railroad, Utilities and Energy; Finance and Financial products. In 2010, it wrote more than $30 billion in insurance premiums, and total revenues exceeded $136 billion. Including its vast equity portfolio and $40 billion in cash, total assets amounted to $372 billion. Berkshire remains active on the acquisition front, and is always looking to bolster its vast operations with new purchases. It consistently targets companies that are managed well, are among the market leaders in its particular industry, and generate material cash flow.

Investment Consideration

As mentioned earlier, Berkshire Hathaway has two classes of stock. Due to the A-shares’ hefty stock price, the B-shares are typically more appealing and obtainable for the majority of investors. Berkshire’s stock has performed remarkably well since Mr. Buffett took control, and the company’s prospects, due to its variety of successful businesses, is solid. Thus, we recommend Berkshire stock to buy-and-hold investors. Lastly, the company’s healthy track record and excellent financial position, make this stock an appealing choice for conservative accounts, as well.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.